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02/07/2010

The Question of Consumer Competence—Posner

When is it proper for government to try to protect people, in their capacity as consumers of goods and services, from themselves? And not just children or people with serious mental problems, but normal adults. Can’t normal adults protect themselves? And if they can’t, won’t competition among sellers protect them?

These questions are acutely raised by the proposal, now before Congress, to create a Consumer Financial Protection Agency that would protect consumers of financial products such as mortgages and credit cards and payday loans not only from misrepresentations by sellers of these products, but also from their own ignorance or poor judgment. The proposal draws on behavioral economics, which teaches that cognitive and psychological limitations frequently lead consumers to make mistakes, even when there is no fraud by sellers.

The specific proposal seems to me misconceived. Its premise is that the housing bubble and ensuing financial collapse were due in significant part to reckless borrowing to finance home purchases or borrow against home equity in order to obtain cash to buy other goods and services. The argument is that people didn’t realize the risk involved in buying a house with very little (sometimes zero) equity, especially if they financed it by an adjustable-rate mortgage, which might become unaffordable by them if interest rates rose.

No doubt some people didn’t realize they were taking a risk, but I don’t think that that is the explanation for the housing bubble. Almost no one, including sophisticated economists and financiers, realized that the steep increase in housing prices that ended in 2006 was a bubble phenomenon. If it was not, then homebuying wasn’t really risky, because one could anticipate that the market value of one’s house would grow, and this would create sufficient equity to be able to refinance one’s mortgage on attractive terms. There was a speculative element but it did not seem extreme because so few experts believed there was a housing bubble. Among these experts notoriously was Ben Bernanke.

I want to contrast with the proposal to curtail risky borrowing by consumers two types of consumer protection that seem to me justifiable, and this regardless of the insights of behavioral economics. One is requiring cigarette labeling and advertising to carry warnings of the health hazards of smoking. This regulation is not very important today because everyone knows about these hazards, but it was important in the 1960s when the existence and gravity of the hazards were first confirmed. Obviously individual consumers were not in a position to study the health effects of smoking—which cigarette manufacturers were busy denying—but one might think that advertisers of competing products would have had an incentive to frighten consumers away from smoking. But this would not be a realistic expectation. What would consumers think if a manufacturer of chewing gum advertised that chewing gum, unlike smoking cigarettes, does not cause lung cancer? Nor would cigarette manufacturers whose cigarettes contained less tar and nicotine than the average be strongly motivated to advertise the fact, because they would be telling the world that cigarettes are hazardous, at a time when this was not generally realized. Automobile manufacturers were slow to offer seatbelts, perhaps fearing they would be advertising the dangers of driving—and charging a higher price (to cover the cost of the seatbelts) at the same time.

My second example is inspections of restaurants and food processors by government inspectors, to prevent food poisoning. One can imagine leaving food safety to the market, reinforced by tort remedies against the sale of unsafe products. But solvency limitations would make market and tort remedies ineffectual against many sellers, especially small and new ones—so the inspection regime actually facilitates new entry, which is a dominant feature of the restaurant industry. Food poisoning can cause death, indeed multiple deaths, and when the consequences of a market failure are very grave, there is an argument for preventive regulation.

Now I want to discuss an important intermediate case, where the argument for consumer protection seems to me stronger than the case for consumer financial protection (other than against fraud), but not so strong as in the cases I just gave. That is the case of obesity. According to the Weight Control Information Network, which is part of the National Institutes of Health in the Department of Health and Human Services—and I believe reputable—two-thirds of American adults are overweight and one-third—an astonishing percentage—are obese, defined as having a Body Mass Index (the ratio of a person’s weight in kilograms to the square of his height in meters) of more than 30. So, for example, a woman 5 foot 6 inches tall would be deemed obese if she weighed 180 pounds, and a man 6 foot 1 inch tall would be deemed obese if he weighed 227 pounds.

Obesity is measured differently for non-adults, but 17 percent of young children and 17.5 percent of adolescents are estimated to be obese.

These are startling figures, and considerably higher than in virtually any other country in the world. My esteemed colleague Becker has argued, however, that American obesity is not excessive in an economic sense. Obese people may simply have traded off the pleasures (and economy) of eating cheap, tasty, and nutritious food against the costs in disagreeable appearance, impaired mobility, the greater danger of and longer recovery time from surgery, and the much greater incidence of Type II diabetes and joint problems; there is also a greater risk of heart disease and possibly of dementia. Becker believes that the long-run expected costs of obesity may be small if continued advances in medical technology eliminate or greatly reduce the health problems that obesity creates, and that the realization of this possibility is one of the factors that people consider in deciding whether to allow themselves to become obese.

I am skeptical. The problem of obesity is concentrated in the poorer segment of the population, among people with limited education who may be unable to assess the health risks of obesity and as a result are unwilling to incur the slight added expense (or cost in diminished eating enjoyment of a diet less rich in sugar and butter). They may also be imperfect agents of their children; and a person who becomes obese as a child will find it more difficult to avoid obesity than people who were thin children. Governmental paternalism when directed to children is less problematic than paternalism toward adults.

There is also an externality, which is a nonpaternalistic justification for government intervention. The government, meaning ultimately the taxpayer, now pays for half of total U.S. medical expenses. The average medical expenses incurred by obese people are substantially greater than those of the nonobese, even after allowance for the shorter life spans of obese people. (It has been responsibly estimated that obesity and overweight add $150 billion a year to the nation’s medical bill. This is somewhat too high because it ignores the effect of obesity in reducing longevity. On the other hand it excludes the $40 billion a year that people spend on diet programs.) Much of the additional cost to Medicare, Medicaid, and other public programs is borne by taxpayers who are not obese. Private health insurers are forbidden to “discriminate” against the obese by charging higher premiums to them, which is an unsound policy that should be changed (it won't be). But probably many obese people are not insured, and their medical expenses are paid by charity or government, for example when they seek medical care in hospital emergency rooms and cannot pay the price they are billed for that care. Failure to pay the full medical costs imposed by obesity distorts the decision of a person to become or remain obese; it is a subsidy for obesity. I find it difficult to imagine a more grotesque subsidy.

But whether it would be desirable for the government to try to reduce obesity depends on the cost and efficacy of the measures it might take. Some of the common proposals are likely to have only modest effects, such as requiring restaurant menus to disclose calories. People who are motivated to avoid obesity know or can easily discover the approximate caloric content of the various foods, and people have most of their meals at home rather than in restaurants.

Somewhat more promising measures are: instruction in nutrition and the dangers of obesity in elementary and high schools; healthful school-lunch programs; expanded compulsory physical education in schools; restrictions on foods that can be purchased with food stamps; a tax on advertising fast food; a tax on video games; a ban on food advertisements aimed at children; a relaxation of regulations of health insurance that discourage charging higher premiums to the obese (and that thus subsidize obesity); a tax on soft drinks that contain sugar; and a calorie tax. All would be relatively inexpensive measures that would have a good chance of paying for themselves. The last, the calorie tax, which would probably be the most effective measure, would be a Pigouvian tax—a tax designed to internalize an externality, and, as such, defensible on standard economic grounds if I am correct that obesity creates an externality.

Still, such a tax can be criticized on two grounds. One is that it would be strongly regressive. But its regressive effect could be offset by a more generous food-stamp program. The second objection, emphasized by Becker, is that a tax on calories penalizes people who are not obese, and they are the majority. It is the same objection that can be made to alcohol taxes as a means of curtailing drunk driving: most of the people taxed are not drunk drivers. A more efficient anti-obesity tax, in principle, but utterly infeasible politically, would be a head tax measured by weight.

I am not much impressed by “fairness” objections to taxes. Taxation is inherently arbitrary, because it doesn’t match the taxes paid by a person to the services he receives from government or the costs he imposes on society. A calorie tax would raise considerable revenue, because like most Pigouvian taxes it would result in only limited substitution away from the taxed good, and the government at present is in desperate need of additional revenue.

A more efficient tax would be a tax on producers of food, based on the difference between the cost of the ingredients before processing and the price for the finished product. The tax would therefore fall more heavily on highly processed foods, which tend to be higher in calories, than on lightly processed ones.

More study is necessary, however, before the costs and benefits of a well-designed program of obesity reduction can be responsibly assesssed.

Comments

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Some states require the physical presence of an attorney or delegate at residential real estate closings. (In the case of North Carolina, where I am a member of the bar, this is accomplished through attorney professional responsibility and unauthorized practice rules.) If we stipulate that the consumer competence problem is a real one, could one intermediate solution less costly than a federal CFPA be for states to impose similar representation requirements on borrowers at the promissory note-signing stage of the purchase process?

Some might complain that this would impose an additional homebuying cost on those least likely to afford it, but I'd have to think that a market for low-cost home loan legal advice would arise (I think Prof. Becker would agree). And those buyers who don't lack for competence and understanding on the borrowing end would choose the best-matched mortgage product on their own, well in advance of hiring the lawyer, so they could keep their legal expenses to a minimum.

For no other reason, this proposal might ensure that a less-than-"competent" homebuyer could have someone explain to them the ramifications of certain nonconventional mortgage products before signing the note.

And one more thought - haven't some of these consumer competence issues been mooted, at least for the time being and in the residential real estate market, by the financial crisis itself? I imagine that not too many prospective buyers are now being steered toward adjustable 2/5 and 1/6yr ARMs, interest-payment-only ARMs, mortage/home equity combos, and all of the other nonconventional products that were pushed on me and my wife when we bought our first home back in 2001. And once the bubble burst, the number of first-time aspiring home-flippers in high-default states like FL and CA plummeted, which reduced the pool of prospective homebuyers lacking the necessary "competence." (As Judge Posner has pointed out, it was entirely rational for buyers to jump on the home buying bandwagon, given the potential returns the bubble's expansion promised. With no bubble, those buyers are all out of the market.) Both the definition of "eligible buyer" and the range of financing options therefore seem to have narrowed, and the 30yr/20% down mortage we wanted (and finally got, after fending off all of the aforementioned steering) may now be the lender's first choice as well as the borrower's.

If the gummint were really interested in curing the stupidity of the American people, it would have to start with advisories against religion and other superstitions, including "sanctity of marriage," followed by advisories against voluntary insurance of all kinds.

Nothing is more non-sensical than those. Indeed, sex (kissing) and owning pets like cats and dogs would be proper subjects of advisories as well, since a plethora of deadly and debilitating diseases are transmitted by them as well. Unlike genetic and environmental illnesses, they can be easily avoided by an educated public.

Obesity, on the other hand, is not easily avoided, being part genetic and part a product of poverty.

There's an important corollary - relevant to US health-care-reform efforts - to the statement that American obesity rates are significantly higher than in other developed countries.

One often hears the statement that "US real per-capita health spending is much higher than in any other country, and yet our average lifespan is no greater. *We don't get anything for our extra spending!*"

But that statement contains a logical error because "longevity" is not the proper measure of what one gets out of health-care spending. "Maintenance costs" are a more apt analogy. Imagine two individuals who buy identical automobiles. One drives sensibly and conducts routine oil changes, while the other drives recklessly, and perform no regular care on the vehicle, crashes often, and occasionally has to spend significant amounts in repairs.

Now, if both cars last 15 years, but the reckless driver spent twice as much on maintenance and repairs as the safe one over that time, it would be ridiculous for him to say, "Well, I spend twice as much as that guy over there, but our cars lasted for the same amount of time, so *I didn't get anything for my extra spending!*"

What he got was 15 years, where his choices at an equivalent level of lifetime spending would have left him with significantly less longevity.

I think the American health-care expenditure example is analogous. We drive our bodies more recklessly on average, of which our obesity rate is a symptom, and a lot of our "extra" spending may be what it medically costs (in any country) to preserve the longevity of people with unhealthy lifestyles.

This was a principle reason I was highly skeptical on the administration's claim to be able to "bend the curve" in health-care outlays through comparative-effectiveness and best-practices research because, after all, "Other countries with state-run plans are able to spend less than we are, so there's no reason our own central planners shouldn't be able to achieve similar results".

But there is a reason - that reason is Americans cost more to keep alive. And if we can't lower those costs or change habits, and we accept collective responsibility for the provision of all medical services - we will quickly go bankrupt.

So, to put it in less euphonious terms, first you compel me to pay my neighbor's medical bills, and then, because his obesity now has externalities, you tax my ice cream to control his weight. Surely there's a better way.

This sounds like the arguments used against the creation of the Food & Drug Administraion and other consumer protection groups like the Dep't. of Agriculture. "Why do we need an Agency that regulates Food and Drugs? Can't people determine for themselves when food is rotten or contaminted and drugs like Laudanum or Dr. John's Miracle Medical Elixr are worthless or downright dangerous?"

As for regulating and controlling the Financial and Commercial Industries in the interest of the Public Welfare; the Creators of those toxic Finacial Instruments and other obtuse, exotic, and downright bizarre Financial instruments
which have been the bane of the American and World Economy as of late; the creators, even have no idea of what they are, how they work (if they work at all) and their impact on the Public Welfare. And you want the general public to fend for themselves? Talk about legitimizing "pigs in a poke", "shell games", "ponzi schemes" and other bizzare business practices as the Hallmark of World Economic Order and Enterprise.

No wonder we have economic problems we can't seem to get straightened out.

Now..., in terms of regulation and control, of basic health care reform and obesity, there has to be a two pronged approach to the solution of the problem. That is, obesity has two components of the problem. Caloric Intake and Caloric Expenditure. By establishing Pigouvian Taxes and the like to drive the cost of consumables up and reduce consumption (based on the causal aspect of increased cost - less demand) and at the same time, reduce overall medical expenses for the problems caused by obesity; will in all probability not be a fully effective counter measure because of the second prong of the problem. Caloric Expenditure.

If an obesity solution is to be developed, the solution must solve both prongs of the problem, Caloric intake and Caloric expenditure. Driving food costs up will drive down consumption. The other solution that must be incorporated is the increase of Caloric Expenditure and that can only be achieved by a dramatic increase in physical activity. In other words, get the kids out of in front of the TV, Videos, Computers, Game boys and other sedentary activites and outside where they can walk, run, jump, swim, bicycle and participate in any and all types of physical activity.

Government works for capital. Those who join capital under the umbrella of government necessarily become wards of government, a ward of capital, with the associated exponential opportunity costs. Those costs have now caught up to capital.

Subsidizing consumer decisions results in greater and greater subsidies, which sink the economy. The underlying problem is lack of transparency, encouraged by the worst culprit, the law, which ensures that system errors are assigned to individuals, so the system is never corrected, and losses are assigned to the taxpayer. Now the system is bankrupt, and capital is trying to escape. Capital is in crisis because it has no escape. All it can do is continually sacrifice parts as the implosive pressure increases.

Government, non-profits, and union hierarchy all work for capital. Capital gets 49% of the economy, and unprotected labor gets 51%. Regardless of the nonsensical misdirection, capital has a choice; it can increase the return to unprotected labor, decrease asset prices, or a combination of the two to get the 49 and 51 numbers. The amount of pain to capital and all its tentacles depends on capital. Everything else is misdirection.

Capital will continue to sink until it jettisons family law, which shorts the articulating mechanism between natural and government systems. Without durable new family formation, health, there is no economy, and legacy systems can only liquidate.

The only difference between this cycle and every other cycle is global communications, with several billion people watching the process, and 100s of cultures cross-checking the data. Capital is doing what is always does, trying to prove that it does not need small labor. It chose of its own free will to jump into that quicksand.

Placing an unbearable burden of controlling financial pyramids between producers and consumers, and then telling the economic slaves that they should get more nutritional food is a bit disingenuous. Leave it to the law to address symptoms for profit, and never the underlying cause. It wouldn't be quite so bad if doctors had not followed suit, along with the university system.

Every so often, the middle class needs to be reminded to keep its distance from capital. Capital creates wards of government, through family law, then argues that they need a nanny, government, a self-reinforcing system. Where exactly is family law listed as a power bequeathed by the people to government under the constitution? Oh, that's right, a hand full of people paid for by capital created that one out of thin air.

Real tax receipts will continue to fall, regardless of rates, social demand will continue to increase, regardless of legislative decree, and infinite monetary expansion to continue issuing the checks will end as it always ends, badly.

If you have an economic motor that will pull that $500 Trillion in global unfunded liabilities, you might want to present it soon. Biofuel, solar, wind, and, now, trains, are not going to get it, not by a long shot.

Maybe profesor Becker could write a post explaning to us his views on the obesity issue with greater detail. As someone who is not american and lives in Mexico, a country with similar health problems among its population, Im aware that a lot americans are overweight. I dont consider that the goverment should be telling people how, what and how much to eat. Profesor Becker is looking at this problem as a trade off between a) becoming obese and b)paying less for food. Although I love to see economics everywhere it seems to me that this problem is more cultural and social than economical but I understand about the effects, specialy on budget.
But just take a look at tv programs, video games and so on. Kids dont play anymore so they are not use to physical activities and parents are too busy making more money to buy that big screen tv to watch football on saturdays, so they cant or dont want to lose their afternoon taking kids to play ball.Who wants to go outside with that shiny sun and clean air to ride around in a bike when you have wi fit at home where you dont need to talk or see anyone else. Maybe send a twitter about wanting to go outside XD. Well, I may have gone on a tangent there but its, sadly,truth.
Goverment in Mexico has something call PROFECO that is supposed to watch for the consumer safety but we havent gone as far as saying consumers are dumb...of course, PROFECO doesnt work. It just makes a bigger goverment budget.

Economic profit results when the SAME ACTION creates increased return and decreased cost. Only you can decide the value of return and cost for you. Over time, monetary (and fiscal) policy is self-correcting. Don’t fight it; ignore it.

Life can be extremely unfair in the short term, but it is extremely fair over the long term, because life is a distribution of unpredictable events. Don’t get hung up on the extremes. Set yourself up to be patient; that is the key to investing, at every level.

Don’t let the accountants fool you into letting the lawyers put a gun to your head. Returns and costs are not separable, and any law that attempts to violate that law will be overturn in due course. The law is a tiny spec in the universe. Productive habits always prevail.

Money is nothing more than a communication tool, a poor one at that when its definition is left in the hands of a few. The difference between capitalism, communism, and socialism are negligible compared to any one of the three and democracy.

Legal training in and of itself is less than useless. Combined with productive capacity, it is invaluable. If you must choose, choose the latter, and leave the Court to die of its own volition.

Give unto Caesar that which is Caesar’s in the short term, and always bet on democracy long term.

Taxing people to stop a bad behavior creates perverse incentives where it's in the government's interest that the bad behavior not stop because it causes a loss of tax revenue. At a minimum, if the tax actually does succeed in reducing the behavior, the government will end up raising the tax higher to make up for the "lost revenue" that it's now addicted to. If the behavior stops entirely, the tax will be moved to some similar target--it's never going to go away just because the behavior does, so you just raised taxes in general.

Such taxes also have a way of expanding far beyond their initial mandate, for reasons far beyond their initial reasons. It might become a general public health tax, or a general consumer product tax, but it's guaranteed that a calorie tax won't be limited to calories.

Also, I have a modest proposal: along with video games, put a tax on movies. Just like people who play video games, people who watch movies are not out there exercising. In fact, we could add books to the tax. Of course, the point is that you can't just put a tax on video games on the grounds that someone playing them isn't exercising--you also have unstated premises about video games being less valuable than books and movies, premises which are necessary to your argument but which you may have trouble defending.

I hate to go against something Prof. Warren so strongly favors, but my seasoned extinct tells me the consumer financial protection agency is as much a financial services reform bill-breaker in Congress as the Medicaid backroom deals were to healthcare. Real estate law is State law, not national law. Contract law and negotiable instruments law are State law. Mortgage and lien law is State law. And the States are all over the map on land titles, inheritance and succession, rights upon marriage and divorce, a mortgage as legal title versus naked security for a debt, exemptions of property from judgment creditor and bankruptcy claims, private non-judicial foreclosures versus judicial-only, and whether a foreclosing creditor can sue the debtor for a deficiency. The law that affects consumer interests arising from these things has already been "federalized" to the limits of practicability - interest rates and fees, RESPA disclosures, TILA disclosures, FCRA recordkeeping and scoring, HOEPA protection against predatory lenders, and FDCPA protection from abusive debt collectors. If I were king I'd forbid "home equity" lending, securitization of residential mortgage loans, and adjustable rate homestead purchase money notes. That used to be the law in many States. Unsexy maybe, but it kept many families in shelter by keeping the deal simple. And the bank never had to puzzle even in the worst of downturns whether X's simple-interest loan was current or delinquent.

Being fat is a habit. It will be easier to enforce good habits than to tax bad ones. We need to be proactive and stop children from getting fat in the first place. Mandatory physical exercise should extend through all four years of high school. This is even crazier than a fat tax, but I propose that every citizen be required to pass basis physical fitness test in order to get a driver's license. Grandfather everyone in, and make new 16 year old applicants pass a fitness test. Give kids a goal to work towards, and by the time they reach it, they will already have good habits. Seriously though, the processed food tax sounds pretty good to me. However, I prefer a solution that puts the burden on the individuals to improve themselves, rather than a more paternalistic option.

As for State law being Sovereign... Well - yes and no. It's all tied up in Constitutional Law. Specfically, the applicability of Federal Law trumping State Law via the 14th Amend. not too mention the 13th, 15th, 18th, 19th, 23rd, 24th, 26th Amendments. As for that odd case of "City of Boerne vs Flores-1997?" it just threw in the principle of "Congruency & Proportionality".

State's Rights went out with Secesionism in 1865. Unless of course, you happen too be a born again Secesh.

Give kids a goal to work towards, and by the time they reach it, they will already have good habits. Seriously though, the processed food tax sounds pretty good to me. However, I prefer a solution that puts the burden on the individuals to improve themselves, rather than a more paternalistic option.

In a perfect world, the individual might pickup the burden, but the world and humanity are less than perfect. Hence, the rise of Behaivorism and the rise of Positive and Negative Sanctions. Negative Pigouvian Tax, increased food cost- Negative Sanctions. Positive Pigouvian Tax, tax cut for proper body mass index level- Positive Sanction.

The externality of obesity is actually surprisingly low when all costs/benefits are netted. See Jeff Strnad, Conceptualizing the 'Fat Tax': The Role of Food Taxes in Developed Economies. 78 Southern California Law Review 1221.

A different scenario is also plausible, and it leaves a little more room for a CFPA. In this scenario, the foolishness was heterogeneous. Some people were fooled by a bubble, like the people who bought the high risk Bear-Sterns fund that collapsed in summer 2007. Others didn’t worry about a bubble because they thought they were hedged through credit default swaps. That almost turned into a second disaster because no one knew the real exposure of the issuers like AIG. Send in the Feds, which gave us Maiden Lane III. Still others didn’t worry because their exposure was so brief (sub-prime originators), which is a kind of hedge. Others didn’t care because they made so much money during the boom that they didn’t mind losing whatever was on the table when the collapse, which they knew was eventually coming, came. Lucian Bebchuk nicely documents the money those folks made in a recent paper discussed here.

This scenario disputes the Posner-Becker “state of the world” which implies there was only one rational thing for everyone to do, and into this state of the world we put the homeowners. They are also heterogeneous. The “flippers” for example are another type of investor, some made money and other did not, some hedged and some did not. A CFPA is not for them.

A CFPA might have helped those who were risk averse and were looking for a home to live in for a long time. A CFPA might have explained to these folks that they, unlike many others, would not be hedged, and so they would be in big trouble if housing prices stopped rising. This might have gotten through to the risk averse. At least it would have been a different message than they were getting, e.g., "you are a sucker if you miss this." An ideal CFPA would have gone even further, pointing out "gloomy" facts everyone knew at the time, e.g., incomes were rising much more slowly than housing prices and this could not go on. These warnings--and their rational basis--might have gotten the attention of these homeowners and warned them away from option arms and the like.

Even apart from the bubble scenario one can ask whether a CFPA would take disclosures more seriously (i.e., do consumer testing) than the existing regulators. Becker-Posner argue as if the only rationale for a CFPA is to help homeowners avoid being injured by a bubble. That is not the only real rationale even if it was offered as the political rationale. The claim a CFPA will hurt consumers has to take seriously the extent they are being hurt right now and whether net benefits are higher.